In 1994, the British government created the Enterprise Investment Scheme (EIS) to motivate investors to back early-stage and entrepreneurial companies. After recognising the many benefits these businesses contribute to the British economy, the scheme supports these companies in raising initial capital – and the investors who are helping these businesses get off the ground.
Through a variety of tax reliefs (when you first invest and then when you realise your investment) the EIS scheme does well to recognise the significant risks involved for investors when financing these companies starting out. As expected, when you invest in these early-stage businesses, returns can significantly vary. EIS loss relief is a tax benefit available for investors through the EIS scheme, which works to minimise the effects of any potential losses.
For investors considering backing a new business through the Enterprise Investment Scheme, this article explains everything you need to know about EIS loss relief, covering how you can calculate loss relief – and then claim it.
Please note that the information below is for general informational purposes only. For further clarification, please seek professional tax advice before making financial decisions.
What is EIS loss relief?
Given the uncertainty of returns from early-stage and entrepreneurial companies, loss relief lets investors offset losses made on EIS businesses against their own capital gains or income tax charge. This means that EIS investors may not lose 100% of the value of their investment.
It’s important to note that even if you have an EIS portfolio which has achieved a positive return overall, it’s still possible to claim loss relief for investments in independent companies that have fallen in value.
What value qualifies for loss relief?
If you want to qualify for loss relief from your investment, the realised worth of your investment needs to have dropped below the ‘effective cost’. This value works out as the amount you first invested minus the income tax relief claimed from the EIS investment.
What does this look like in numbers? If you invest £50,000 in an EIS business and claim an income tax relief of 30% (£15,000), the effective cost equals £35,000.
If you want to claim loss relief, you need to have enough tax liabilities to offset this. Likewise, you need to claim this loss relief within a specific timeframe for it to be successful.
How to claim loss relief against your income tax
If you’re an EIS investor, you can offset losses against your income tax bill for both the current and the previous tax year. To calculate the amount of tax relief you can claim, multiply the value of the effective, or “allowable” loss by their marginal rate of income tax.
A numerical example goes as follows. Say the effective cost of your investment was £5,000, and you managed to sell your investment for £1,000, the allowable loss would work out as £4,000. Given the marginal rate of income tax was 45%, the total worth that you could claim as loss relief would be £1,800 (£4,000 x 45%).
How to claim loss relief against capital gains tax
As well as offsetting your losses against income tax, you can also offset your losses against capital gains tax for the current tax year or the upcoming one. To work out the loss relief in this scenario, multiply the allowable loss by the rate you pay capital gains tax.
For example, if the capital gains tax rate is 20% and you make an effective loss of £4,000, the amount of loss relief you could claim would be £800 (£4,000 x 20%)
Explaining deferred capital gains
After you invest in an EIS business, it’s possible to defer a capital gain. If this happens to you, you can charge the gain at the prevailing rate on the date the EIS shares were disposed of or the company was liquidated. Since this will effectively then treat your original gain as a new capital gain, you must declare it on your tax return. However, it’s possible to use your annual capital gains tax exemption (now £12,300) against this gain. Alternatively, you can offset the loss from investing in an EIS company against the deferred gain.
Things to remember about EIS loss relief
Tax treatment is subject to change
Since tax treatment is reliant on circumstances, it’s important to remember that it can also change. Similarly, tax reliefs are very dependent on the businesses in your portfolio sustaining their EIS-qualifying status. If you do have a portfolio of companies that are EIS-qualifying, you can claim loss relief for a separate business at an effective loss – even if your overall portfolio is performing positively.
Despite claiming loss relief, it’s still possible to lose money overall
Since investing in young companies can be risky, it’s possible that the value of your EIS investment can fall as well as rise. This means you might lose part or all of the amount you first invested. It’s important to remember that this also remains the case if you claim loss relief. Put simply, loss relief only reduces the effects of a loss – it won’t eradicate the impact entirely.
You might be entitled to make a negligible value claim if the worth of your investment falls to zero
If shares in an EIS-qualifying business are zero (or close to zero) but remain unsold, there’s a chance you can claim for the amount of the effective loss. You can submit a ‘negligible value claim’ by informing HMRC that the shares have reached zero.
Beneficiaries can’t claim loss relief for inherited EIS shares if the investment has fallen in value
Since HMRC considers the inherited shares at their market value at the time of death, even if the worth of the shares has decreased since the initial investment date, the deceased’s personal representatives cannot claim loss relief. If you find yourself in this scenario, contact a professional for advice.
How can you claim EIS loss relief?
To claim EIS loss relief against capital gains tax or income tax, you can do so when you complete your self-assessment tax return. There is a specific section of the SA108 form that relates to this.
When you claim EIS loss relief through self-assessment, the amount of tax you need to pay may be reduced. Since you can also claim loss relief retrospectively, HMRC may issue you a refund if you have paid too much income tax for the tax year.